Earnings Call Transcript - SBCF Q3 2022

Operator, Operator

Welcome to Seacoast Banking Corporation's Third Quarter 2022 Earnings Conference Call. My name is Cheryl, and I will be your operator. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. If you have a question, please press 1 on your touchtone phone. Before we begin, I have been asked to direct your attention to the statement at the beginning of the company's press release regarding forward-looking statements. Seacoast will be discussing issues that constitute forward-looking statements within the meaning of the Securities and Exchange Act, and its comments today are intended to be covered within the meaning of the act. Please note that this conference is being recorded. I will now turn the call over to Chuck Shaffer, Chairman and CEO of Seacoast Bank. Mr. Shaffer, you may begin.

Chuck Shaffer, Chairman and CEO

Thank you, Cheryl, and thank you all for joining us this morning. As we provide our comments, we will reference the third quarter 2022 earnings slide deck, which you can find at seacoastbanking.com. I'm joined today by Tracey Dexter, Chief Financial Officer; and Michael Young, Treasurer and Director of Investor Relations. Let me start by thanking the entire Seacoast team for their tremendous effort in recovering from Hurricane Ian last month. All Seacoast branches opened within a few short days and the group quickly transitioned to assisting our customers and communities. Additionally, the team promptly reverted to closing the Drummond and Apollo acquisitions, and one week after the storm passed, they completed the technology conversion at Apollo, which I'll say a little more about in a moment. I'm very proud of our hard work and resilience in supporting our communities in the face of such a challenging weather event. In terms of Hurricane Ian, we reserved a little over $2 million during the quarter related to the storm based on an analysis of our exposure in the hardest-hit counties of Florida and an outreach program executed by our banking team. The results of the qualitative feedback from our bankers and customers, as well as the quantitative analysis performed by our credit analytics team, have been favorable, leading us to believe that the impact on Seacoast may be limited, given the path of the storm, which primarily impacted Southwest Florida, where Seacoast has less exposure compared to the remainder of the state. We expect to have a more complete understanding of the impact by the end of the fourth quarter, but at this point, we believe that any impact on our financial results will be inconsequential. Turning to the third quarter results, the Seacoast team delivered another outstanding quarter of earnings while continuing to execute against our balanced growth strategy. The quarter was highlighted by a material expansion of our net interest margin, which, excluding PPP and accretion on acquired loans, increased 29 basis points from the prior quarter. Net interest income increased 32% on an annualized basis. The cost of deposits increased by only 3 basis points, and annualized loan growth for the quarter was 10%. The company generated $49 million of pretax pre-provision earnings, an increase of 6% from the prior quarter, while achieving a 53% efficiency ratio. Since the start of 2022, the team completed the Sable Palm and Business Bank of Florida transactions, enabling us to enter the highly attractive and growing Sarasota market and continue to grow our presence in Brevard County. Additionally, in early October, we completed the acquisitions of Drummond Bank and Apollo Bank, expanding our presence in North Florida, including Ocala and Gainesville, and expanded our franchise in the dynamic Miami-Dade County market. Also in October, the Apollo and Seacoast teams completed a flawless technology conversion of Apollo Bank, which, despite the disruption of Hurricane Ian, was our smoothest conversion to date. Finally, we announced during the third quarter the acquisition of Professional Bank, expanding our reach further in South Florida. We continue to expect to close this transaction early in the first quarter of 2023. Consistent with our continued focus on organic growth and our goal of being the best commercial bank in Florida, we hired a team consisting of well-seasoned commercial and industrial bankers, treasury officers, and credit officers in North Florida, complementing our acquisition of Drummond and further expanding our reach into Ocala and Gainesville. Additionally, we augmented our commercial banking team in West and Central Florida with several hires from national and regional banks, and we also brought on several credit and operational roles as we scale the franchise. The timing of these expenses came a little earlier than anticipated, but a very strong opportunity presented itself and the payback period on this investment will be short. I want to take a moment to discuss our credit metrics. Seacoast continues to be a disciplined, conservative lender focused on building a carefully underwritten and diversified portfolio by nurturing full client relationships that bring low-cost funding. As a reminder, our portfolio has been built over the long term, with a consistent growth rate while driving diversification by product type, by segment, and by vintage. As a result of this discipline, our credit metrics for the quarter were outstanding, with almost zero net charge-offs, declining nonperforming loans, and declining criticized and classified loans. Moreover, our relationship-based philosophy and heavier focus on operating companies compared to our peers will pay off in the environment ahead by providing lower deposit repricing, as evidenced by our cost of deposits increasing only 3 basis points this quarter. Seacoast is operating from a position of strength, with capital allowance ratios at the top of our peer group. During the quarter, our allowance for credit losses ratio increased to 1.42%, considering the loss absorption included in our purchase accounting marks. The company is reserved at a 1.71% coverage rate. Our tangible common equity ratio was 9.8%, and our Tier 1 ratio was 16.5%. Additionally, we believe Florida has the potential to outperform the rest of the country if a downturn materializes, given the wealth accumulation and population growth over the past few years. Florida has surpassed every state in the nation in attracting affluent and wealthy individuals and corporations during the last two years, adding materially to the state's GDP. To conclude, considering the continued economic strength of Florida, our carefully underwritten credit portfolio, peer-leading capital levels, and our high-quality customer franchise, we have one of the strongest balance sheets in the industry, providing optionality if a recession materializes. This will allow us more flexibility than most to be opportunistic in client selection, organic growth, and acquisition opportunities. I'll now turn the call over to Tracey.

Tracey Dexter, Chief Financial Officer

Thank you, Chuck. Good morning, everyone. Directing your attention to third quarter results, beginning with highlights on Slide 7. The net interest margin expanded 29 basis points to 3.67%, and on a core basis, expanded 33 basis points to 3.57%. Loan originations at higher yields and the low cost of deposits we maintained during the quarter supported higher net interest margin. Our asset-sensitive balance sheet is beneficial in this rising rate environment, which will continue to benefit net interest income and margin in the coming period. Our loan-to-deposit ratio ended the quarter at 76%, leaving us room to continue to fund growth at higher yields in the coming quarters. Our cost of deposits increased only 3 basis points during the third quarter to 9 basis points. We continue to manage deposit pricing on an exception basis, though we do expect to see an increase in the cost of deposits in the fourth quarter, given the velocity of rates over the last 120 days. Pretax pre-provision earnings continue to increase, with results on an adjusted basis up by 6% compared to the prior quarter and 16% compared to the start of the year. We grew loans at an annualized rate of 10% this quarter with the strong commercial talent that we've added to the team in recent periods. I'll emphasize that the growth is in keeping with the bank's credit standards and is a combination of solid production in the quarter and slowing loan prepayments. Average core loan yields increased 20 basis points to 4.3%, and the September weighted average add-on yields reached 5.5%. Credit risk metrics remained strong, with nonaccrual loans lower compared to the previous quarter and only $100,000 in net charge-offs. The quarterly provision for credit losses includes the estimate we made at quarter end to provide for losses potentially resulting from the impact of Hurricane Ian, though we've not seen any specific concerns at this point. Overall coverage reflects economic factors, including persistent high inflation and expectations for higher rates. In deposits, while balances were down overall, which I will discuss shortly, average balances in noninterest-bearing demand accounts increased quarter-over-quarter despite the typical summer seasonal decline. Wealth Management was a particular bright spot during the quarter, with large wins in assets under management and our ability to provide existing client relationships with access to higher rates. Notably, we moved $100 million in cash deposits into either money market funds or the bond market to achieve returns for our clients while keeping those funds within the Seacoast relationship. An update on Hurricane Ian: We suffered no notable damage to any of our properties, nor was there any damage to the Apollo, Drummond, or professional locations. Branches were quickly reopened after the storm, and only a small percentage of loans in our portfolio are collateralized by properties in the most highly impacted areas. Our borrowers, so far, appear to have fared well. In the allowance for credit losses as of September 30, we included an estimated $2 million for potential losses, having limited information at the time about the economic impact from the storm. Now that we're a few weeks on, we've been able to confirm that for the large majority of our borrowers, things are back to business as usual. As you know, there's been significant activity on the M&A front, including the October closings of the Apollo and Drummond transactions on October 7 and the announcement of the upcoming acquisition of Professional Bank in South Florida. Closing is expected early in the first quarter of 2023, with system conversion late in the second quarter of 2023. Turning to Slide 8, net interest income expanded 8% during the quarter, adding $6.6 million with higher yields and a shift in asset mix. Net interest margin expanded 29 basis points to 3.67%, and excluding PPP and accretion on acquired loans, which introduced significant variability, net interest margin increased by 33 basis points to 3.57%. In the securities portfolio, we've continued to pace our investments of excess liquidity, and yields increased 38 basis points to 2.36%. Core loan yields expanded 20 basis points to 4.3%, and in September, add-on rates averaged 5.5%. We continue to benefit from a strong low-cost funding base, with 65% transaction accounts as of September 30. This strength was further enhanced in October with the acquisitions of Apollo and Drummond banks, which have similarly long-standing granular relationships. Looking ahead, we expect net interest income and margins to continue to benefit from rising rates. In the fourth quarter, we expect the core net interest margin, excluding purchase accounting accretion, to expand to the high 3.90s. We expect net interest income in the fourth quarter to be in the range between $115 million and $120 million. Moving to Slide 9. Adjusted noninterest income was $16.5 million, a decrease of $0.8 million from the previous quarter and a decrease of $2.6 million from the prior year quarter. The decrease from the prior quarter and prior year is largely driven by lower mortgage banking activity impacted by rising rates and limited housing inventory. I'll point out that wealth revenue overcame third quarter market conditions to remain flat with the addition of significant new relationships. Other categories were generally stable, with increases in SBIC investment income offset by lower loan swap-related income and lower SBA gains during the quarter. Looking ahead, we continue to focus on growing our broad base of revenue sources, and with the benefit of the expanded franchise, we expect fourth quarter noninterest income in a range of $18 million to $22 million, which is inclusive of the operations of both Apollo and Drummond. Moving to Slide 10, adjusted noninterest expense for the quarter increased $5.2 million to $56.9 million. Included in the quarter are approximately $2.6 million in unique expenses, including the provision for unfunded commitments, elevated recruiting costs, and project-related expenses that are not expected to recur in the coming period. Salaries and benefits increased $0.9 million, reflecting successful recruiting, particularly with the addition of new commercial banking talent. All in, there were 15 new commercial bankers and treasury sales professionals, including a new team in Ocala. Expansion and support functions reflect the acceleration of investments to scale the growing organization. Noninterest expense includes the provision for credit losses on unfunded commitments, reflecting modeled results of changes in economic factors. In other expenses, $1 million of the increase from the prior quarter relates to a gain in the prior quarter on the sale of an REO property, causing a decline in the comparative results. Also included within the other category are nonrecurring charges related to investments and initiatives in the third quarter. Not reflected in adjusted results is $900,000 in write-offs of certain leasehold improvements. We took the opportunity during the third quarter to purchase two branch properties that we had been leasing, which will lower ongoing occupancy expense by approximately $300,000 annually. Looking ahead, we expect to maintain our expense discipline while continuing investments to support growth. We expect fourth quarter expenses, scaling with the growing size of the organization and excluding the amortization of intangible assets, to be in the range of $72 million to $77 million, inclusive of the operating results of both the Apollo and Drummond entities. As a reminder, the full benefit of cost synergies on both the Apollo and Drummond transactions will not be recognized until the second quarter of 2023. On Slide 11, the efficiency ratio on an adjusted basis remained flat quarter-over-quarter. As we scale the company for growth and become the leading bank in our Florida markets, we continue to pace our investments with discipline, evidenced by our consistent focus on efficiency. Looking forward to the fourth quarter, we expect the efficiency ratio to be in the low to mid-50s with the addition of both banks, and then we'll move lower from that point forward as we execute against the cost synergies of the combined organization. Turning to Slide 12, highlighting the continued diversity of our exposure and concentration levels that remain well below regulatory guidance and the peer group. This diversification highlights our disciplined approach to managing concentration. Construction and commercial real estate concentrations remain well below regulatory guidelines. Turning to Slide 13, our loan outstandings increased by $161 million or 10%, excluding PPP on an annualized basis. The commercial pipeline increased to $530 million at quarter end and includes a number of loans where closings were delayed into the fourth quarter due to the disruption of the hurricane in the last few days of September. Average core loan yields increased by 20 basis points during the quarter, with the September weighted average add-on yields reaching 5.5%. Importantly, since the majority of our variable rate loans are tied to prime, and the prime rate didn't reset until the end of September, we can compare the ending portfolio yields at September 30 to those at June 30. Our ending portfolio yields increased 35 basis points to around 4.5% at September 30. Much of the benefit of the third quarter rate movement will be seen in the fourth quarter. Loan yields will continue to benefit from the higher rate environment, and we expect core yields in the fourth quarter, excluding purchase accounting accretion, to expand meaningfully into the 70s range. Additionally, in the fourth quarter, we expect loan growth to continue with an annualized growth rate in the high single digits. Turning to Slide 14. In the investment securities portfolio, the average yield increased during the quarter by 38 basis points to 2.36%, with purchases concentrated early in the quarter near 4%. The value of the portfolio continues to be negatively affected by higher rates. We will opportunistically seek to redeploy portfolio runoff and take advantage of higher rates while prioritizing the utilization of cash for loan production. Moving to Slide 15, deposits outstanding were $8.8 billion, and I'll take a moment to address the decline in deposits. The team did an excellent job managing our deposit cost this quarter with our cost of deposits increasing by only 3 basis points. Deposits declined by $423 million, with $100 million moving to Wealth AUM; $110 million decline in public funds as municipalities moved funds to the state's investment program; $41 million of time deposits; and $25 million of brokered deposits. When you look at the components of the outflows, only about $150 million exited the bank with some impact from rate sensitivity and a general absorption of liquidity in the market, but not otherwise inconsistent with our typical seasonal trends during the Florida summer period. I'll remind you that our deposit book is primarily from small business and consumer operating accounts in keeping with the relationship nature of our business model, and these accounts are typically less rate-sensitive compared to other deposit funding categories. Transaction accounts represent 65% of total deposits, and the strength of the deposit base, we think, will start to show up as a differentiator among our peer group. Regarding deposit pricing, we expect the competitive environment to become increasingly dynamic. We have a very strong deposit base and expect that we'll continue to outperform our peers on deposit beta, though we do expect to see our own cost of deposits start to increase at a faster pace than in the third quarter. Moving to Slide 16, the allowance for credit losses increased during the quarter by $4.6 million to an overall $95.3 million, with an increase in coverage of 3 basis points to 1.42%. The provision this quarter was $4.7 million. We remain watchful of inflation pressures and are carefully considering the impact of higher rates on the economy, though our credit metrics remain very strong and continue to improve. We'll continue to take a conservative approach to provisioning and have considered the potential for losses related to the impact of Hurricane Ian in the estimate. On to credit metrics on Slide 17. We're seeing sustained positive trends with net charge-offs near zero, nonperforming loans decreasing to 0.32% of total loans, and the percentage of criticized loans to risk-based capital moving lower this quarter. We continue to assess the environment and the factors that might affect loan performance. This quarter, the allowance for credit losses is modestly higher at 1.42% of total loans. Turning to Slide 18, our capital position continues to be very strong. Tangible book value per share is $15.98, a decline from last quarter that's attributed solely to the decline in accumulated other comprehensive income, a result of recording increasing unrealized losses in the securities portfolio. Without the year-to-date impact of securities valuations on AOCI, tangible book value per share would have been $18.92. The ratio of tangible common equity to tangible assets increased to 9.8% and remains among the highest in our peer group. Regulatory capital ratios were not affected by changes in securities valuations. The Tier 1 capital ratio was 16.5%, and the total risk-based capital ratio was 17.5%. Finally, on Slide 19, a longer-term look at tangible book value per share. Over the last five years, we've achieved a compound annual growth rate of 8%, driving shareholder value creation. Without the impact of securities valuation declines on AOCI, that compound annual growth rate was 11% over the five-year period. Our growth outlook remains favorable as evidenced by growth in commercial loans driven by the expansion of our commercial banking franchise. Rising REITs will continue to have a materially positive impact on net interest income and margin in the fourth quarter. All this on a foundation of strong liquidity and capital positions us to maximize opportunities and continue to execute on our strategic growth initiatives. We look forward to your questions. Chuck, I'll turn the call back to you.

Chuck Shaffer, Chairman and CEO

Thank you, Tracy, and Cheryl, I think we're ready for Q&A.

Operator, Operator

Our first question comes from Brandon King from Truist Securities. Your line is now open.

Brandon King, Analyst

Thank you, good morning.

Chuck Shaffer, Chairman and CEO

Good morning, Brandon.

Brandon King, Analyst

Yes, good morning. I want to start on deposits. I understand you're bringing on a sizable amount of deposits with acquisitions, but I wanted to know what the outlook for organic growth is in the near term?

Tracey Dexter, Chief Financial Officer

Hey, Brandon, this is Tracy. Outflows in transaction accounts in the third quarter really didn't appear to be largely rate-driven. I kind of broke down the balances there, but we expect to continue to see headwinds to overall deposit growth in the fourth quarter. We do expect to see others move quickly on deposit pricing, and just the general absorption of liquidity across the system will probably be a factor. But all that said, Q4 is typically an active and pretty strong quarter for deposits with seasonal inflows for us. We're conscious of the velocity of change in the market, but we'll continue to be intentional in our actions. We're competitive and focused on relationships. So far, we've been willing to let some of the transaction and rate-focused deposits go, but we'll just continue to be intentional about that.

Brandon King, Analyst

Okay. With the acquisitions coming online and then being closed, could you update us on what the marks were and what you're expecting for purchase accounting accretion in the fourth quarter? Yes. It's all pretty recent, so we're still in the process of finalizing the mark. We really don't have anything to share at this point about the October 7 close. Okay. And the high 3.90 net interest margin, is that on a reported basis and on a core basis? The high 3.90s margin is on a core basis. Okay. All right. Well, I'll stay back in the queue. Thank you for taking my questions.

Operator, Operator

Thank you. Our next question comes from Stephen Scouten from Piper Sandler. Your line is now open.

Stephen Scouten, Analyst

Hey, good morning, everyone. Guys, I'd love to hear what you're seeing more holistically throughout your environment loan demand. It looked like the pipelines were back up a bit quarter-over-quarter, which is nice to see. I’m curious about what you're hearing from your customers and how you're thinking about demand into the next quarter and into '23, given the environment and all we're seeing and hearing.

Chuck Shaffer, Chairman and CEO

Yes, if you take a broader view, I'll begin by emphasizing the importance of being thoughtful as we navigate this period. We are very deliberate about what we are willing to include in our portfolio and what we are not. Historically, we have expressed our goal of being a conservative lender, and we continue to maintain discipline and a focus on diversity. This approach has positioned us well. Over the past 18 months, we have made significant hires and have observed valuable relationships transferring to us. What excites me is that we're not just acquiring loans but also bringing in deposits, wealth, and comprehensive relationships from other institutions. I believe this positive trend will persist. We have built a strong commercial banking team recently and are committed to its growth. Looking ahead to the upcoming quarter, we anticipate a high single-digit growth rate. We are intentional about upholding our underwriting standards and have scaled back in certain asset classes according to current conditions. We remain vigilant in monitoring how operating companies manage their margins in this inflationary environment, but we are also cautious and strategic. The encouraging news is that as many players shift back to a conservative stance, it allows us to secure preferred structures and pricing. We remain disciplined early in this cycle, which enables us to be thoughtful as we navigate this stage and ultimately achieve the risk-adjusted returns we desire.

Stephen Scouten, Analyst

Yeah, that's great color. Are you seeing any kind of changing dynamics from competitors? That last comment may indicate that you’ve seen some larger regional banks or smaller banks pull back to create opportunities for you guys?

Chuck Shaffer, Chairman and CEO

There definitely is a significant pullback in commercial real estate across the markets. I would say that you've seen commercial real estate spreads widen significantly, and we definitely see the competition pulling back.

Stephen Scouten, Analyst

Okay. Great. It seems like the strength of Florida in a weakening environment nationally would only shine through more. Population flows are still strong, and the real estate market is still relatively strong there compared to the rest of the country. Would you expect your deposits and your geography to be a big differentiator in a less certain environment?

Chuck Shaffer, Chairman and CEO

What I like about where we are is we have optionality as we move through time. If you step back and look at the position of our balance sheet, look at the capital we carry, the reserves and the allowance, the reserves and the purchase marks, the strong, diverse core customer base, and the discipline we've executed over time, combined with what Florida has been, particularly over the last three or four years. If you look at the amount of wealth accumulation coming to market and the economic drivers, I definitely think Florida outperforms through this cycle. What gives me comfort is that we do have the strength in this balance sheet. We have the optionality that will provide opportunities again to take advantage of organic growth through well-priced, well-structured credit relationships, deposit relationships as well as potential acquisitions over time. I think we are about as positioned as best as we can be. This is a moment where a company like ours tends to perform. When you step back and look even more broadly as we pull these three deals together, our ultimate goal is to come out the other side of these deals with a 160-plus return on tangible assets in the back half of the year after we execute against the cost savings. When you have that profitability momentum, the capital, and the position of strength, and the momentum with our culture and the company and the desire to be a part of our company, we're in really good shape. But as we move through this period, we need to be thoughtful, cautious, conservative, and very aware of the risks that are emerging in the economy.

Stephen Scouten, Analyst

Yes, great color. If I could squeeze in one last question around the pro forma balance sheet with Professional, I see they're up to around a 90% loan-to-deposit ratio. Do you guys have a feel for where we might be on a loan-to-deposit ratio perspective and how to protect your deposits with this absorption?

Chuck Shaffer, Chairman and CEO

We're in the mid- to high 70s, probably when you put all three organizations together as we move through this period. The good news is on all of our transactions, they're tracking with the models when you look at the income being generated. In all cases, just like you're seeing across the banking system, balance sheets tend to be a little smaller, but margins tend to be a lot higher. I think we're in good shape going into this period. Their loan-to-deposit ratio is a little higher; ours is a little lower. It certainly is way lower. When you put it all together, it really probably doesn't move the needle from where we are much, which still gives us a lot of liquidity as we move through time to redeploy in the loans.

Michael Young, Treasurer and Director of Investor Relations

And Stephen, this is Michael. I was just going to add that really we're just working to optimize the rate volume mix as we move forward. We're obviously in a very dynamic environment, so we'll continue to monitor and manage through that to optimize profitability and returns to shareholders.

Stephen Scouten, Analyst

Perfect. Appreciate the color. It sounds like a lot of good things to come.

Operator, Operator

Thank you. Our next question comes from Brady Gailey from KBW. Your line is now open.

Brady Gailey, Analyst

Thank you. Good morning. I just want to be clear on the expense guidance, the $72 million to $77 million. So that includes the two acquisitions, and that excludes the intangible amortization. Does it also exclude merger charges?

Tracey Dexter, Chief Financial Officer

It does. It excludes merger charges.

Brady Gailey, Analyst

It seems like this is a significant increase from what was previously expected. While I acknowledge your comments about the hiring you've undertaken, I'm curious if there are other factors contributing to the rising expenses, or if it's solely related to the hiring.

Chuck Shaffer, Chairman and CEO

There are a few points to address. I believe the consensus did not fully account for a complete quarter's performance. Since we indicated that we closed in Q4, it was an early closure. Another factor is Drummond, which does not file a 10-Q, making it challenging to view the entire consolidated financials, including the insurance subsidiary. When we analyze the numbers thoroughly, it appears we are aligned with our expected run rate. Regarding expenses in Q3, we took the chance to recruit what I consider to be one of the best teams in the I-75 corridor—a strong, high-performing team that is likely the largest we've acquired thus far. This affected the quarter due to some one-time signing bonuses and other costs, but the return on this investment will be significant for our growth in that market. When combined with Drummond's acquisition, it creates a powerful team.

Brady Gailey, Analyst

Are you continuing to focus on hiring efforts while looking for new acquisitions and opportunities for growth? Do you anticipate that expense growth might be slightly higher? I understand it will yield returns over time, but do you expect to maintain a hiring pace that is above average?

Chuck Shaffer, Chairman and CEO

I think it probably slows, Brady, to some extent, given where we're going into potentially a slower economy. In all likelihood, we won't be hiring at the pace we have. I think there will be hires along the way, but I think there will also be some costs that come out along the way. I don't think it moves at the pace it is over time. That being said, if we see great opportunities, we're going to take them. The market for that has been better than I've seen in many years. We'll be careful and cautious. Ultimately, again, just kind of pointing back to coming out of the other side of the deal, I'd like to be at north of a 160 return on tangible assets. I think that will generate strong operating profits and strong returns as we move through time. We'll continue to manage towards that. We've got to balance the costs through the deals and manage the investments we're making for growth. But when you go through all that, that's where I want to land.

Brady Gailey, Analyst

You guys have been active on the M&A front over the last few years. Professional is a fairly large transaction for you all. Do you take a breather after you close Professional on the M&A side, especially considering the economic uncertainty? Or do you keep on going on that front?

Chuck Shaffer, Chairman and CEO

Yes. I describe it this way: Our short-term focus right now is integrating the three banks. That has to be our focus. We might look at more deals as we move through next year. The challenge right now is that given the dynamic environment, modeling deals is particularly challenging when you look at deposit funding costs and a weaker economy. It's possible, but for now, we're focused, laser-focused on integrating the deals and coming out with a strong profit profile.

Operator, Operator

Our next question comes from David Feaster from Raymond James. Your line is now open.

David Feaster, Analyst

Good morning, everybody. Maybe can we just touch on the middle market expansion efforts and whether the new hires you've made have been to support that? Any updates on the treasury management build-out? And anything else that you may need in order to support that expansion more towards the lower end of the middle market and support some larger, more sophisticated borrowers?

Chuck Shaffer, Chairman and CEO

Yes. As we've talked, we've been focused on executing against the lower end of the middle market. Moderate-sized operating companies have been a target for us, and we’re seeing very good reception in that regard. A fair amount of our commercial banking hires over the last year are C&I operating focus hires, including the team we just put inside the company. We’ve made great progress on that. I’d say we're about two-thirds to three-fourths of the way through the treasury build. There’s probably a little more cost to come on that; it’s not anything material, but we still have some build to do there. But as we go into this period, when I look forward into what is probably the most important thing we can be focused on, which is funding and deposits, having a well put together C&I-focused commercial banking team and complementing that with strong treasury officers alongside the investment we’ve made in technology late last year and early this year really puts us in a position to begin to take material market share over the next few years. We’ve made real progress there, David.

David Feaster, Analyst

That's great to hear. Asset quality remains outstanding; you have a great understanding of the local economy. You mentioned some competitive dynamics in commercial real estate. I'm curious, as you look at the landscape, we're not seeing any issues in your portfolio, but is there anything you're monitoring more closely? Are higher rates beginning to influence cap rates at all? Are there any other trends within your portfolio or the industry from a competitive perspective that you think are worth mentioning?

Chuck Shaffer, Chairman and CEO

I feel really good about our book. I think it's performing extremely well, and I feel good about it over the cycle. We have been very focused on maintaining discipline. I would say cap rates really have not yet adjusted to the reality of higher rates. I still think that is a risk. Probably the biggest risk to all banks right now is higher medium to long-term rates on the treasury curve. If that were to move up, I think the impact on commercial real estate valuations would be an issue we would be dealing with. You need to be really cautious there. We’ve really sort of pulled out of nonmedical office, retail unless it's truly credit tenant-anchored. We've pulled out of hotels. We're not bringing on any builder lines or land loans, and we’re very cautious with self-storage. We’ve taken a pretty conservative approach on what we’re willing to do. With the potential impact of higher rates on cap rates, we’re expecting a lot more equity in transactions, basically demanding more equity in transactions on the commercial real estate side. It’s definitely not an environment where you want to get over your skis. It’s not an environment where you want to be driving really high growth rates. It’s an environment to be thoughtful, cautious, and make sure you have the right sponsors. Importantly, probably most importantly, along with sponsorship, would be having underwriting structures that will protect the bank through cycles. It’s a constant conversation here and a key focus of ours. That being said, in Florida, things remain very benign. You can see by our portfolio past dues are well contained, classified accounts keep coming down — it’s probably the most pristine credit environment that we've ever seen. So, it's a concern about the future, but not the current period.

Michael Young, Treasurer and Director of Investor Relations

And David, just to rewind a quarter or two as well, when other peers were growing at much faster rates, we stressed a lot of our commercial real estate deals at those higher leverage points, and a lot of those pushed out of our pipeline. Now we're seeing that market come back to us where people are willing to accept those higher amounts of equity that we force into the deals.

David Feaster, Analyst

That's a good point. Last one for me, just maybe touching on rate sensitivity. You guys have done a great job driving margin expansion. The balance sheet is naturally rate sensitive. I’m just curious, how do you think about managing rate sensitivity going forward? Obviously, with another 75 basis points supposed to be coming next week and likely another 75 in December. I’m curious how you think about managing rate sensitivity and potentially locking some of this in?

Chuck Shaffer, Chairman and CEO

Yes, we continue to be really thoughtful there, David. Over the last couple of years, we've demanded a lot of our commercial real estate loans move to swaps and therefore we see a larger portion of our portfolio moving to variable. On the deposit side, we’ve followed the national banks closely and have been slow to reprice deposits, focusing on profitability. We've always been an asset-sensitive organization; the crown jewel of the company is the deposit franchise. I believe the deposit franchise will outperform. That said, like Tracy mentioned earlier, it has definitely gotten more dynamic. We’re seeing rate specials from national banks hitting the market now; it’s definitely gotten more competitive. Ultimately, we'll see margins expand into this quarter, maybe a little into the first quarter, and then we’ll have to see where rates go. It’s hard to say, but we’ll be thoughtful there. We’ve managed the duration of the investment portfolio carefully. Most of our liquidity at this point will be used to fund loan growth as we move through time, and we’ll focus on strong margins and profits.

David Feaster, Analyst

That’s helpful. Thanks, everybody.

Operator, Operator

Thank you. Our next question comes from David Bishop from Hovde Group. Your line is now open.

David Bishop, Analyst

Good morning. Thanks for taking my question. How should we think about loan funding into next year? You mentioned that a lot of the cash has been used up. Given what you're seeing in terms of the competitive backdrop for deposits and such, especially with the state of wholesale funding, maybe brokered CDs play a figure role in the near to intermediate term in terms of funding that group?

Chuck Shaffer, Chairman and CEO

I think we still have plenty of liquidity to fund growth for a period of time. The acquired balance sheets will bring liquidity to fund growth. We'll be able to reposition the bond books and use that liquidity for growth over time. So, I think we still have a long road ahead before we get into brokered or higher-cost funding sources. That being said, we probably will begin to compete more with rate in the marketplace with our core customers. I do expect us to continue moving some of our deposits over into our Wealth Management business, just to do the right thing for customers when we can ladder CDs or treasuries for them. But I don't think we will be dipping into non-core or wholesale funding for a period of time.

David Bishop, Analyst

Got it. I think Tracy had mentioned maybe the September core loan yields earlier on the call. Any chance you have the cost of deposits at the same time frame? That’s all I had.

Chuck Shaffer, Chairman and CEO

Yes, we’ve been a little cautious to give guidance on that just given the dynamic environment. I’d point you back to the net interest margin guidance as you model it out; it's really too dynamic to get too specific on cost of deposits. I still think we’ll be better than most, and I don’t think you’ll see a dramatic change, but we do expect it to go up.

Michael Young, Treasurer and Director of Investor Relations

I’d just add that our cost of deposits wasn’t meaningfully different at the end of the quarter than what we reported for the full quarter.

David Bishop, Analyst

Thank you.

Operator, Operator

We have no further questions in queue. At this time, I will turn the call back to you, Mr. Shaffer, for closing comments.

Chuck Shaffer, Chairman and CEO

Okay. Thank you, Cheryl. I appreciate everybody's time this morning, and we'll talk to everybody soon.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.